The SEC Says BioChemics, Inc. Misrepresented its Collaborations with Cynosure and Unilever.

For small companies struggling to raise capital, a collaboration with a well-known and established company is a valuable fact to market to potential investors. Investors may reasonably presume that established companies are skilled at screening and selecting collaboration partners. Only those deemed worthy may collaborate. A collaboration therefore acts like a stamp of approval and a signal that the little company may be positioned to join its larger peers. It is therefore tempting for small companies to exaggerate or even fabricate collaborations with established companies. This type of misrepresentation, when used to raise investor funds, can be securities fraud. The SEC recently brought such a claim against BioChemics, Inc., and its CEO John J. Masiz, for allegedly touting collaborations with Cynosure, Inc. and Unilever United States, Inc., long after the collaborations had ended.

The SEC’s Fraud Complaint.

On December 12, 2012 the SEC filed a civil fraud complaint against BioChemics, Inc. of Danvers, MA, its founder, CEO and Chairman John J. Masiz of Topsfield MA, and two promoters, Craig Medoff of New York City, and Gregory S. Kroning of Norwood, NJ. The complaint alleges a fraudulent scheme to sell BioChemics securities to approximately 70 investors in 19 states that raised at least $9 million. Note: as with any SEC complaint, the facts recited are mere allegations; they may not be true and the defendants have a right to challenge the allegations in court.

The situation looks bleak for BioChemics. For starters, as summarized in the SEC complaint, each of the individual defendants has had a prior serious run-in with a securities regulator. In 2004, for example, the SEC charged Masiz with fraudulent statements in the securities filings of VASO Active Pharmaceuticals, Inc., a BioChemics subsidiary. Masiz settled, agreeing to an $80,000 civil penalty and a bar from serving as an officer or director of a public company for five years. Craig Medoff, who allegedly helped solicit investors, was sued by the SEC in 1993 for selling unregistered stock to the public through the use of materially false and misleading documents. In 1995, the SEC permanently barred Medoff from associating with any broker, dealer, investment adviser, investment company or municipal securities dealers. Medoff also pled guilty to two counts of conspiracy to commit criminal securities fraud. Gregory Kroning, who also allegedly solicited investors for BioChemics, had previously been barred from the securities industry for one year by the New York Stock Exchange.

The complaint alleges that one or more of the defendants: (1) falsely claimed that two drugs were under FDA review; (2) misrepresented the progress and results of clinical trials; (3) misled investors about valuations of BioChemics purportedly prepared by reputable investment banks; (4) misrepresented Masiz’s background and compensation; and (5) used investor funds for Masiz’s personal expenses (meals, massages, clothing and sporting goods) and for a leased BMW for Kroning. Most interesting, however, is the allegation that BioChemics misrepresented its collaborations with Cynosure and Unilever.

Misleading Claims of Collaboration with Cynosure and Unilever.

The SEC claims that in 2010 and 2011 BioChemics, Masiz, and Kroning misrepresented to investors and potential investors the status of research collaborations with other pharmaceutical companies:

“For example, in 2010 and 2011, BioChemics published a multiple-page overview entitled Executive Summary (“Executive Summary”) that touted its research collaborations with Cynosure, Inc. (“Cynosure”), Unilever United States, Inc. (“Unilever”), and Nanobac Pharmaceuticals, Inc. (“Nanobac”), after those relationships were defunct.”

Masiz and Kroning allegedly sent various versions of this Executive Summary to investors and potential investors. Concerning Cynosure, for example, a version from late 2011 stated:

“the parties’ agreement had actually terminated according to its provisions in approximately August 2009. Cynosure informed BioChemics by October 2009 that the project would not be continued. BioChemics acknowledged in internal documents from December 2009 that the Cynosure project “has been terminated.”

The SEC alleges a similar misrepresentation about Unilever:

“Recent (past 12 months) milestones include: . . . Signed a codevelopment relationship with Unilever for the topical delivery of an amino acid which would be a product line extension for Vaseline Skin care, one of Unilever’s branded product lines.”

The SEC claims this was misleading too:

“Although in 2009 the parties had signed an agreement for Unilever to test a BioChemics product on humans, Unilever stopped the test abruptly in November 2009, after the BioChemics product caused adverse reactions on the patients’ skin. Unilever never approved any further testing of BioChemics products and there was no contact between BioChemics and Unilever about the project after June 2010. The Executive Summary falsely indicated that the relationship with Unilever was ongoing, and failed to disclose the material fact that the testing of BioChemics’ product had been halted because of the adverse reaction it caused.”

The SEC complaint also references similar misrepresentations concerning collaboration with Nanobac Pharmaceuticals, Inc. If the SEC’s allegations are true, BioChemics is a good example of a company that yielded to the temptation to misrepresent its collaborations with established companies. In such cases, not only are investors harmed but the established companies may also suffer reputational harm. It is a significant problem in securities law.

The Problem of Falsely Claiming Business Affiliations.

Misrepresentations of business affiliations are often at the heart of fraudulent schemes. It is common, for example, for sellers of bogus investments to claim that reputable and well-known financial institutions participate in the program (these are often called “prime bank” frauds). Others falsely suggest that a reputable person supports the program – a humorous example involving Bill Clinton is found here: “Was it the $5,000 Cowboy Boots?”

In cases such as BioChemics, however, the false claim of collaboration can be more difficult to detect and prevent. BioChemics did, after all, apparently have a previous collaboration agreement with these other companies. For example, a BioChemics collaboration with Cynosure is reported here and with Unilever here. The problem is that BioChemics allegedly kept touting these collaborations after they were defunct. This creates a particularly risky scenario, even for investors who follow the industry. The investors may recall the press reports on these collaborations and thus be disinclined to doubt assertions of current collaborations. Similarly, it may be difficult to recognize when the extent of collaboration is exaggerated. With this type of fraud, there may be fewer “red flags” that a scam is afoot. The false claim may be entirely believable, even to knowledgeable investors. As a law professor might point out, when a type of fraud is difficult to detect, a higher penalty is needed to achieve the desired level of deterrence. For this reason, the false collaboration claims will likely be vigorously pursued by the SEC.

This type of fraud also harms more than just the investors. It harms the established company. The small company making the false claim is, in essence, stealing an implied endorsement from the established company. Further, where the small company is disreputable, potential investors may be surprised to learn of the ill-advised collaboration, but may be disinclined to inquire further. Like campaign advertising, however, the negative association may remain in the investors’ minds. It is a recurring problem, and one with no simple solution. Companies can of course search the Internet for improper claims of business collaboration. But this helps little when the claims are oral, in written brochures, or are only in email. As with trademarks, copyrights and patents, policing false claims of collaboration or affiliation is a constant battle. If the SEC is successful against BioChemics, however, it may cause executives to think twice before making exaggerated or false claims of collaboration.